Tokens have become a crucial element of the Web3 ecosystem, serving as a versatile tool for protocols to represent a wide range of value, from money and membership to identity and incentives. By designing tokens effectively, Web3 companies can incentivize users to engage with their platform and build a strong community around it. However, token design can be a complex process, and there are common pitfalls that designers must be aware of.

In our previous article, we discussed the token design process and some common pitfalls designers must be aware of when considering tokens in their protocols. Once a proper design process is in place, it is important to have some knowledge of the current capabilities of tokens as demonstrated by successful protocols in the web3 space.

We have created this taxonomy of tokens as a rough guide to exploring token capabilities, however, due to the complexity and novelty of the technology, a robust taxonomy is difficult to hold as there are truly many innovative projects that regularly flip everything we know about token capabilities.

Despite this, we still hold it valuable to attempt to catalogue the power of tokens so that new designers can have an easier way entering the token design space. We see this article as constantly in progress, so we will do our best to keep it updated with the latest thinking and encourage you to challenge our decisions!

In this article we will discuss 4 categories evident to us, how they are used and some examples of projects currently under development.

Governance Tokens

Governance (or voting) tokens allow their holders to participate in decision-making processes within a decentralised system. These tokens are usually distributed to users who hold a certain amount of the system’s native cryptocurrency, and they can be used to vote on proposals, upgrades, or changes to the system.

1/ Asset Allocation: Voting tokens can be used to manage a decentralised fund or treasury. Holders of the voting tokens can propose and vote on how to allocate funds or assets within the system. This can include decisions on how to invest or distribute funds, or how to manage the system’s reserve assets.

Example: Maker DAO (MKR) tokens holders vote on are fees, rules and team member appointments.

2/ Software Upgrades: This is very much a native use case, voting tokens can be used to decide on software upgrades or changes to the system. Holders of the voting tokens can propose and vote on changes to the system’s codebase, which can include bug fixes, security enhancements, or new features. This helps ensure that the system is always evolving and improving in a decentralised way.

Example: Compound (COMP) holders have voting rights to propose and approve changes to the Compound protocol, such as adjustments to interest rates or the addition of new assets to the platform.

3/ Social Consensus Mechanism: Voting tokens can also be used as a social consensus mechanism within a decentralised system. This means that holders of the voting tokens can collectively decide on the rules, policies, and governance structures for the system. This helps to ensure that the system remains decentralised, transparent, and resistant to centralization or manipulation by any one party.

Example: Sismo Contributor Badge Holders are regularly consulted on the direction the direction of the project.

Transaction Tokens

Payment tokens are a type of cryptocurrency token that is primarily used for making payments within a decentralised system. These tokens are designed to be fast, secure, and cost-effective, and they can be used for a wide range of transactions, including peer-to-peer payments, merchant transactions, and micropayments.

The three main use cases for payment tokens are:

1/ Internal Payment Tokens: Payment tokens can be used within a decentralized system as a means of exchange for goods and services. For example, in a decentralised marketplace, buyers and sellers can use payment tokens to buy and sell products without the need for a central authority to facilitate the transaction. This helps to reduce transaction costs, increase transaction speed, and eliminate the risk of fraud or chargebacks.

Example: An example of an Internal Payment Token is the Basic Attention Token (BAT), used within the Brave browser ecosystem for transactions between users, advertisers, and publishers, creating a decentralised system without a central authority.

2/ Network Resource Tokens: Payment tokens can also be used as a means of accessing network resources within a decentralised system. For example, in a decentralized storage network, users can use payment tokens to pay for storage space, bandwidth, and other resources. This helps to incentivize network participants to provide resources and ensures that the network operates efficiently and securely.

Example: Filecoin (FIL) is a decentralised storage network that allows users to buy and sell storage space on the network using FIL tokens. FIL tokens are used to pay for storage space, bandwidth, and other network resources, and are also used to incentivize network participants to provide storage resources.

3/ Arcade Tokens: Payment tokens can also be used as in-game currency for gaming platforms and arcade games. Users can purchase arcade tokens with payment tokens, and then use them to play games and access premium features. This helps to create a vibrant ecosystem of gamers and developers, and it provides a secure and transparent way for users to purchase and use in-game currency.

Example: Enjin Coin (ENJ) is a payment token used as in-game currency for gaming platforms and arcade games, allowing users to purchase in-game items and access premium features in a secure and transparent way.

Stakeholding Tokens

Stakeholding tokens are digital tokens that represent ownership or investment in a particular asset or project, such as a company or a real estate property. These tokens are built utilise blockchain technology to enable secure and transparent ownership and transfer of value.

One of the key benefits of stakeholding tokens is that they allow for fractional ownership of assets that were previously only accessible to a select few. For example, if a real estate property is tokenized, investors can buy and sell fractional ownership of the property, which makes it possible for smaller investors to participate in the market.

The three main use cases for stakeholding tokens are:

1/ Entitled to a return through a smart contract: Stake holding tokens can be designed to entitle their holders to a return on their investment through a smart contract. This means that the returns are automatically paid out to token holders based on the rules of the smart contract. This capability allows for a high degree of automation and transparency in the distribution of returns.

Example: MakerDAO (MKR) issues a stablecoin called DAI that is backed by a basket of other cryptocurrencies. Holders of MakerDAO’s MKR token are entitled to a share of the fees generated by the system, which are automatically paid out through a smart contract.

2/ Entitled to a return through a legal agreement: Stake holding tokens can also be used to entitle their holders to a return on their investment through a legal agreement. This means that the returns are paid out based on the terms of a traditional legal contract, rather than through a smart contract. This capability allows for greater flexibility in the terms of the investment, but may also be subject to more regulatory scrutiny.

Example: Despite a lot of talk of ‘security tokens’, we have not seen a lot of promising projects in this space. One project that arguably uses this capability is Harbor, which issues security tokens that represent ownership in real estate properties. Holders of these tokens are entitled to a share of the rental income generated by the properties, which is paid out based on the terms of a legal agreement.

3/ Underwrites risk in exchange for returns: Stake holding tokens can also be designed to underwrite risk in exchange for returns. This means that token holders take on some of the risk associated with a project or investment, in exchange for a share of the potential returns. This capability allows for greater alignment of incentives between investors and project founders, as both parties have a stake in the success of the project.

Example: Augur (REP) issues a token called REP that is used to bet on the outcomes of events. REP holders can earn returns by correctly predicting the outcomes of events, but they also bear some of the risk if their predictions are incorrect.

Metadata Tokens

Metadata tokens are tokens that represent data or metadata on a blockchain. The data can be anything from a digital asset such as a document, image, or video, to an identity or reputation. Metadata tokens are typically used to facilitate the exchange of data on a blockchain, allowing users to securely and transparently transfer ownership or access rights to data.

1/ Membership: Metadata tokens can be used to represent membership in a specific group or community, such as a club or a network of professionals. Members can use these tokens to access exclusive content, services, or events, as well as to participate in governance and decision-making processes.

Example: Binance (BNB) is used to access special features and discounts on their trading platform. Another example would be Friends With Benefits (FWB), a social network that enables token holders access to exclusive features and perks, and can participate in the community’s governance and decision-making processes.

2/ Reputation: Metadata tokens can also be used to represent reputation or credibility within a specific context or industry. Reputation tokens can be earned based on various factors, such as contributions to a community, successful projects, or endorsements from trusted sources. Reputation tokens can then be used to access higher levels of services or benefits, or to demonstrate expertise and trustworthiness to others.

Example: Gitcoin, a platform that issues reputation tokens to developers based on their contributions to open-source projects. Reputation token holders can then use their reputation to access exclusive funding opportunities and other benefits.

3/ Identity / Reference: Metadata tokens can be used to represent digital identity or reference data, such as a user’s personal information or proof of ownership for a particular asset.

Example: Ethereum Name Service (ENS) issues a token called ENS that represents ownership of a specific domain name on the Ethereum blockchain. ENS token holders can use their token to manage and transfer ownership of their domain name, as well as to access other services and features related to their domain name.

4/ Off-chain data: Metadata tokens can also be used to represent off-chain data on a blockchain, such as data stored on a separate database or server. This can allow for more efficient and secure exchange of data between parties.

Example: Chainlink (LINK) is used to pay for access to data feeds from off-chain sources. Or another example could be

5/ Permissions / Auth Capabilities: Metadata tokens can also be used to represent permissions or authentication capabilities on a blockchain. This can include access to certain resources or the ability to perform certain actions.

Example: Aragon (ANT) is used to grant voting and governance rights to members of their decentralised autonomous organisations (DAOs).

6/ Interfaces / View: Metadata tokens can also be used to represent user interfaces or views of data on a blockchain. This can include customised views of data or access to certain features.

Example: 0x (ZRK) is used to access different user interfaces for their decentralised exchange protocol. Also, there are teams such as Party DAO looking to create tokens with a whole html webpage, interface and control of the interface within the token. So essentially the token enables control of the token. A very interesting project which could enable decentralised interfaces in the future.

Conclusion

In conclusion, tokens have become a critical component of Web3 protocols, enabling developers to create robust and efficient economic systems around their products and services. In this article, we have explored four categories of tokens, including governance tokens, payment tokens, metadata tokens, and stakeholding tokens. By understanding how tokens work and their capabilities, designers can incentivize users to engage with their platform and build a strong community around it.

As the Web3 ecosystem continues to evolve, it is essential to keep up-to-date with the latest thinking on token design and capabilities. We encourage readers to challenge our taxonomy and provide feedback. Also if you know of any project worth checking out, please reach out as we are constantly trying to stay on top of Web3 design.

For more on our design philosophy, check out Mike Taylor, partner and project manager at Verum Capital, who is currently releasing a series of articles on the topic of Web3 design.

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